BENTHAM INSTITUTE OF MANAGEMENT AND LANGUAGES

OrangePulp
Financial Appraisal
R.Avinash Narayana
3/30/2010
Contents

Contents.......................................................................................................................................................2
Introduction.................................................................................................................................................3
Cost and Revenue Forecasting.....................................................................................................................3
Scatter Plot and free hand graph method analysis....................................................................................3
Linear Regression....................................................................................................................................4
Time-series analysis.................................................................................................................................4
Method of Least Squares:........................................................................................................................4
Expenses..................................................................................................................................................5
Revenue Forecasting................................................................................................................................6
Sources of funds for an organisation..........................................................................................................12
Long-Term Finance...............................................................................................................................12
Short Term finance................................................................................................................................14
Cost of Capital...........................................................................................................................................15
Recommendations for obtaining funds......................................................................................................16
Long-term..............................................................................................................................................16
Short term..............................................................................................................................................16
Conclusion.................................................................................................................................................18
Bibliography..............................................................................................................................................18

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Introduction

“Business entities need to plan for the future, must consider alternative management strategies
and prepare capital and operating budgets, and must also consider alternative funding and cash
budget possibilities. An important part of the planning process is the preparation of prospective
financial statements that attempt to predict the outcome of the business entity's activities in future
periods.” (Bernard Newman, 1999)

“Financial planning is a continuous process of directing and allocating financial resources to

meet strategic goals and objectives.”(Matt H. Evans, 2000a)

Such planning can be construed only if an extensive understanding of the future is achieved. This
report provides an accurate and unbiased picture of the financial aspects of the new venture,
OrangePulp, intended to be started at Hyderabad.

FloridaOrange is an established company based in Delhi. Using FloridaOrange’s past experience

in the field of orange juice production, this report aims at forecasting an estimate of the
company’s (OrangePulp) income, investment and expenses. Hence, a comprehensive prediction
of the company’s growth can be arrived at.

Cost and Revenue Forecasting

There are several forecasting methods of which a few are listed below

Scatter Plot and free hand graph method analysis

Scatter plots are obtained when two variables are plotted against each other on an x-y plane.
They are used for analysing numerical data in the free hand graph method by drawing a trend

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line guessing the general direction of the plotted values. Though easy to understand this method
provides multiple answers and hence gives little chance for accuracy and reliability.

Scatter Graph for

Five Observations

s $1,700
r
a
ll $1,650
o $1,600
D
s $1,550
e
l
a $1,500
S
$1,450
$0 $100 $200 $300
Adve rtising Dollars

Linear Regression

We can rely on the average relationships between a dependent variable and an independent variable.
Simple linear regression looks at one independent variable (such as sales pricing or advertising expenses)
and makes use or a scientific method (ex: Method of least squares) to arrive at a straight line which
explains the trend of the values.

Time-series analysis

This analysis is the same as linear regression model with one difference regarding the
independent variable which is always time. This analysis tries to establish the future values of the
dependent variable using the aforementioned trend line

Method of Least Squares:

This method is a forecasting technique which has been used in the following cost and revenue
forecasts. According to S.P.Gupta & M.P.Gupta (2005), this method is most widely used in

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practice. It helps to fit a trend line to the data. This trend line helps us to gather future values of
the corresponding data.

As an example, the working of Price forecast of one unit of the product, orange juice, has been
shown in the “Revenues” section

Expenses

Using an initial five-month-projection of the company’s expenses in various categories, the

future costs have been estimated and tabulated, using the straight line trend methods which
include the method of least squares, as follows. The values have been calculated for the next 24
months.

Month (In ‘000s, Indian Rupees)

Cost 1 2 3 4 5 6 7 8 9 10 11 12
Machinery parts 500 500 500 500 500 500 500 500 500 500 500 500
Maintenance 100 100 100 100 100 100 100 100 100 100 100 100
Insurance 300 300 300 300 300 300 300 300 300 300 300 300
premium
Rent 300 300 300 300 300 300 300 300 300 300 300 300
Utility bills 100 105 110 115 120 125 130 135 140 145 150 155
Storage 150 155 160 165 170 175 180 185 190 195 200 205
expenses
Inventory 200 180 140 120 140 180 200 200 180 200 200 200
purchase 0 0 0 0 0 0 0 0 0 0 0 0
Travel , Admin 100 105 110 115 120 125 130 135 140 145 150 155
Expenses
Selling & Dist 50 50 55 55 60 65 70 70 75 75 80 80
Expenses
Salaries/Wages 100 100 105 105 110 110 115 115 120 120 125 125
0 0 0 0 0 0 0 0 0 0 0 0
Postage 15 16 17 18 19 20 21 22 23 24 25 26
Legal 100 100 100 100 100 100 100 100 100 100 100 100
consultation fees
Reserve 500 500 500 500 500 500 500 500 500 500 500 500
Running Cost per 521 503 470 451 478 521 548 549 536 558 565 567
Month 5 1 2 8 9 0 1 7 8 4 5 1

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 Month (In ‘000s, Indian Rupees)
Cost 13 14 15 16 17 18 19 20 21 22 23 24
Machinery 500 500 500 500 500 500 500 500 500 500 500 500
Maintenan 100 100 100 100 100 100 100 100 100 100 100 100
ce
Insurance 300 300 300 300 300 300 300 300 300 300 300 300
premium
Rent 300 300 300 300 300 300 300 300 300 300 300 300
Utility bills 160 165 170 175 180 185 190 195 200 205 210 215
Storage 210 215 220 225 230 235 240 245 250 255 260 265
exps
Inventory 200 180 140 120 140 180 200 200 180 200 200 200
0 0 0 0 0 0 0 0 0 0 0 0
Admin 160 165 170 175 180 185 190 195 200 205 210 215
exps*
Selling&Di 85 85 90 90 95 95 100 100 105 105 110 110
st Exps
Salaries 130 130 135 135 140 140 145 145 150 150 155 155
0 0 0 0 0 0 0 0 0 0 0 0
Postage 27 28 29 30 31 32 33 34 35 36 37 38
Legal 100 100 100 100 100 100 100 100 100 100 100 100
consultati
on fees
Reserve 500 500 500 500 500 500 500 500 500 500 500 500
Running 574 555 522 504 531 573 600 601 589 610 617 619
Cost per 2 8 9 5 6 2 3 9 0 6 7 3
Month

Revenue Forecasting

The Price per one unit (Y) of orange juice in Indian Rupees for the last fourteen months has been
given as follows. Based on these values, the future values of the same can be forecasted using the
Method of least squares.

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Mont Price/u Taking
h nit deviations
from month7 XY X2 Trend
values
Y X Yc
1 254 -6 -1524 36 251.66
2 252 -5 -1260 25 252.03
3 254 -4 -1016 16 252.4
4 255 -3 -765 9 252.77
5 253 -2 -506 4 253.14
6 252 -1 -252 1 253.51
7 250 0 0 0 253.89
8 252 1 252 1 254.26
9 254 2 508 4 254.63
10 250 3 750 9 255
11 258 4 1032 16 255.37
12 255 5 1275 25 255.74
13 257 6 1542 36 256.11
14 261 7 1827 49 256.49
N=1 ∑Y=35 ∑XY=18 ∑X2=2 ∑Yc=355
4 57 ∑X=7 63 31 7

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 Trend Line

The straight line trend equation is represented by

where the values a and b are given by the two equations

----- (1) , ------ (2)

Multiplying equation (2) by two and subtracting equation (1) from it we get

(-)

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Hence, these values are substituted in the equation for Yc and the trend line equation is obtained.

As the goods are delivered at the end of the month and payments are made five months after
delivery of goods, the payment of the output produced on month 1 would be made in month 7
and so on. Using this equation and substituting values of X>7, we can obtain the future values of
the price per unit of orange juice the following

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 X
Mont value Trend Outpu Revenu
h s values t e
Y(Rs.) (Rs.)
1 8 256.86 40000 0
2 9 257.23 40000 0
3 10 257.6 40000 0
4 11 257.97 40000 0
5 12 258.34 40000 0
6 13 258.71 40000 0
102742
7 14 259.09 40000 86
102891
8 15 259.46 40000 43
103040
9 16 259.83 40000 00
103188
10 17 260.2 40000 57
103337
11 18 260.57 40000 14
103485
12 19 260.94 40000 71
103634
13 20 261.31 44000 29
103782
14 21 261.69 44000 86
103931
15 22 262.06 44000 43
104080
16 23 262.43 44000 00
104228
17 24 262.80 44000 57
104377
18 25 263.17 44000 14
114978
19 26 263.54 44000 29
115141
20 27 263.91 44000 71

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 115305
21 28 264.29 44000 14
115468
22 29 264.66 44000 57
115632
23 30 265.03 44000 00
115795
24 31 265.40 44000 43

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Sources of funds for an organisation

Long-Term Finance

“The long-term investments we make today will determine the value of our business tomorrow.”
(Matt H. Evans, 2000b)

Long-term investments are made in order to acquire new product lines, new equipment and other
assets which give their return in the long-term (>1 year). Features of long-term financing are:-

• Higher rates compared to short term sources of financing

• Less liquidity

• Permanent working capital

• Decreased interest rate risk meaning they are less prone to fluctuations.

• Decreased credit risk

• Decreased profitability.

When a company raises capital, it has three choices - issue

• Debt- Debt is represented by bonds and debentures which are long-term instruments sold
to investors. The company is required to pay these investors a fixed amount of interest for
a defined period of time and repay the principal amount after maturity.

• Equity shares- Stock or equity share is the ownership interest of the business and
depending upon the rules of incorporation, stockholders will have certain rights. These
equity shareholders are part-owners of the company and are paid dividends after
preference shareholders.

• Preference shares- Preference shares are similar to equity except that preference
shareholders are not given rights to the company but are paid their dividends first.

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In addition to these methods a company can also borrow funds as a loan at a rate of interest for a
long-term.

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 Stock
Advantages
• No fixed payments are required to
investors; dividends are paid only as
earnings are available.
• No maturity date on the security, the
invested capital does not have to be
repaid.
• Improves the credit worthiness of the
company.
Disadvantages
• Dilutes the earnings per share to
shareholders.
• Issuance costs are higher than debt.
• Issuing more stock can increase the
overall cost of capital.
• Dividend payments to shareholders
are not tax deductible.
Debt
Advantages
• Interest payments are tax deductible.
• Does not dilute earnings per share or
control within the company.
• Cost is fixed; interest and principal do
not change.
• Expected returns to investors are
usually lower than stock.
Disadvantages
• Fixed charges must be paid regardless
of available earnings or cash flow.
• Adds more risk to the business.
• Has a maturity date and the capital
invested must be repaid to investors.

Short Term finance

Short term funds mainly invested for short term needs mainly in the form of working capital
finance. They mature very fast usually in less than one year.

Overdraft: An amount allowed by the bank to its premium customers as credit without interest
up to a certain limit without having any balance in their account.

Trade Credit: Credit given by bank to the customer by keeping stock as security.

Credit sales: Credit against interest given by banks.

Discounting the bill: Discounting the bill is when a bank provides finance by outright purchase
or discounting the bill arising due to credit sales. It proves to be a costly source of finance.

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Letters of credit: It is the guarantee of a bank for the risk against the payment. This is very
popular source of finance in export and import trade.

Security: This is known as loan against hypothecation or pledge.

Factoring: It is known as buying the book debts of a company.

Accrued Expenses: These are basically liabilities covering expenses incurred on and prior to a
specified date, payable at some future data.

Cost of Capital

The Cost of Capital is the amount, expressed as an annual percentage that a firm must pay to
obtain adequate funds.

Components of Cost of Capital for OrangePulp:

Cost of Equity: Cost of equity is represented by Ke.

Ke is calculated using the formula

Ke = D/Po +g. Where g = growth rate, D = Dividend, Po= Share value

So Ke=3/32 + 7%= 0.16375 = 16.375%

Cost of Retained Earnings: Cost of retained earnings Kr is calculated as follows.

Kr = Ke(1-T) In the case of OrangePulp Kr = Ke = 16.375

Cost of Debt: Taking Kd as cost of debt

Kd = Interest/Net Proceeds. After tax Cost of debt = Kd (1-tax)

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For OrangePulp Kd=15% considering no underwriter fees.

“The weighted average cost of capital (WACC) is the rate of return that the providers of a
company’s capital require, weighted according to the proportion each element bears to the total
pool of capital.”(Pratt, Shannon P., and Roger J. Grabowski, 2008)

Recommendations for obtaining funds

Long-term

As an initial investment towards purchasing land, building and machinery ten crore rupees are
required. To raise capital for this amount the company should issues debts worth ten crore rupees
at 15% for 15 years. In Indian Rupees

Interest paid per year = 15% x 100,000k = 15,000k

Interest paid per month = 15,000k/12 = 1250k

Principal cost per month = 100,000k/(15 x12) = 555.56k

Cost paid towards debt per month = 1805.56k

Short term

As the company doesn’t start making profits until the seventh month, the excess operational
costs incurred in the first sixth months are to be financed with a short term source of finance.

Short term funds required = 5770.56+5586.56+5257.56+5073.56+5344.56+5765.56

(in Rs.‘000s) = 32798.33

Therefore, debtor factoring would be a viable option this funding

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Accounts receivable to be factored = 32798.33 x 100/95

(in Rs.‘000s) = 34524.56

In '000s, Indian Rupees

Mont
Revenu Operational
h Expenditure(inclu Profit
e cost
ding int+prin)
-
5770.5
1 0 5215 5770.555556 6
-
5586.5
2 0 5031 5586.555556 6
-
5257.5
3 0 4702 5257.555556 6
-
5073.5
4 0 4518 5073.555556 6
-
5344.5
5 0 4789 5344.555556 6
-
5765.5
6 0 5210 5765.555556 6
10274. 4237.7
7 29 5481 6036.555556 3
10289. 4236.5
8 14 5497 6052.555556 87
4380.4
9 10304 5368 5923.555556 44
10318. 4179.3
10 86 5584 6139.555556 02
10333. 4123.1
11 71 5655 6210.555556 59
10348. 4122.0
12 57 5671 6226.555556 16
10363. 4065.8
13 43 5742 6297.555556 73
10378. 4264.7
14 29 5558 6113.555556 3
15 10393. 5229 5784.555556 4608.5

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 14 87
4807.4
16 10408 5045 5600.555556 44
10422. 4551.3
17 86 5316 5871.555556 02
10437. 4150.1
18 71 5732 6287.555556 59
11497. 4939.2
19 83 6003 6558.555556 73
11514. 4939.6
20 17 6019 6574.555556 16
11530. 5084.9
21 51 5890 6445.555556 59
11546. 4885.3
22 86 6106 6661.555556 02
11563. 4830.6
23 2 6177 6732.555556 44
11579. 4830.9
24 54 6193 6748.555556 87

Conclusion

Financially, OrangePulp is an exciting prospect capable of sustaining a healthy profit which

would only increase. The risk levels being low and FloridaOrange being an established company
obtaining funds for this new venture will be smooth. OrangePulp is a healthy project to invest in.

Bibliography

Abramson, A. G., & Mack, R. H. (1956). Business Forecasting in Practice: Principles and
Cases. Wiley.

Atkinson, A. B. (2004). New Sources of Development Finance. Oxford University Press.

Gupta, S. P., & Gupta, M. P. (2005). Business Statistics. New Delhi: Sultan Chand & Sons.

Myhre, T. C. (1992). Financial Forecasting at Martin Marietta Energy Systems, Inc. The Journal
of Business Forecasting Methods & Systems, Vol. 11 .

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Newbury, F. D. (1952). Business Forecasting: Principles and Practice. McGraw-Hill.

Newman, B. (1999). Financial Forecasts and Projections. Retrieved March 24, 2010, from
Encyclopedia of Business, 2nd ed..:
http://findarticles.com/p/articles/mi_gx5209/is_1999/ai_n19125718/

Powelson, J. P. (1960). National Income and Flow-of-Funds Analysis. McGraw-Hill.

Pratt, Shannon, P., & Grabowski, R. J. (2008) Cost of Capital: Applications and Examples.
Hoboken, NJ: Wiley.

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